Pension funds, foundations and endowments allocated roughly $1 billion to hedge fund strategies in the first six months of this year, and plan an additional $1.4 billion to $3.1 billion in investments by the end of 2003, according to an informal survey by Pensions & Investments.
Although relatively small in relation to the size of the hedge fund industry, estimated by New York-based Hennessee Group LLC to be $592 billion at the end of 2002, it represents significant investment by institutional investors. Direct investments in hedge funds by pension funds account for 7% of hedge fund assets, according to Hennessee. Foundations and endowments account for an additional 7%.
Investors who made first-time allocations to hedge funds or increased existing allocations in the first six months of this year include:
-- The $35 billion Virginia Retirement System, Richmond;
-- The $26 billion Massachusetts Pension Reserves Investment Management Board, Boston;
-- The $10 billion University of Texas endowment fund, Austin;
-- The $5.5 billion International Paper Co., pension fund, Stamford, Conn.;
-- The $5 billion Louisiana State Employees' Retirement System, Baton Rouge;
-- The C$2.4 billion (US$1.7 billion) Abitibi-Consolidated Inc. pension fund, Montreal;
-- The $1.2 billion Seattle City Employees Retirement System;
-- The $593 million Allegheny County Retirement Board, Pittsburgh;
-- The $413 million Denison University endowment fund, Granville, Ohio; and
-- The $95 million U.S. Holocaust Memorial Museum, Washington.
Desires to diversify
Driving the allocations are desires to diversify investments and lower risk, pension and endowment officials said. And many of the decisions to make new allocations or increase existing ones are based on asset allocation studies.
"Our consultant (Yanni Partners Inc., Pittsburgh) studied and reviewed our asset allocation and determined we needed to be in some other funds," said Cheryl A. Bateman, executive director of the Allegheny County board. So in early March, the fund gave about 2% of its assets, or roughly $13 million, to J.P. Morgan Fleming Investment Management Inc., New York, to run in a fund of hedge funds, Ms. Bateman said. Funding for the hiring - the pension fund's first to hedge fund strategies - came from reducing allocations to core fixed-income managers C.S. McKee & Co. Inc., Pittsburgh, and Richmond Capital Management, Richmond, Va.
"We reallocated a lot of our managers to get them to their target allocations," Ms. Bateman said. "It was a rebalancing more than anything."
Similarly, the $89 million Sterling Heights (Mich.) General Employees Retirement System is in the midst of a shortlist search for the system's first fund-of-funds manager to handle $4 million, Rick Sanborn, pension administrator, said. The plan launched the search following an asset allocation study conducted by Merrill Lynch Consulting Services, Jersey City, N.J. It is possible the fund might hire more than one firm.
"As a result of the study, we saw that the asset mix that provided the least amount of risk through diversification included a 5% allocation to hedge funds," Mr. Sanborn said. The hedge fund investments "are for the purpose of reducing risk in the overall portfolio and for diversification. Our system is over 100% funded and we'd like to keep it that way."
Sterling Heights officials plan to interview finalists by September and hire at least one firm by the end of the year, Mr. Sanborn said. Funding will come from reducing a $35 million Lehman Aggregate Index fund managed by State Street Global Advisors, Boston.
In March, Montana State University's $50 million endowment fund added to its previous hedge fund allocation of up to $11 million, said Marie Nopper, director of research for the Bozeman-based endowment. The $2 million allocation to Pequot Capital Management Inc., Westport, Conn., and $1 million to Palo Alto Investors LLC, Palo Alto, Calif., bring Montana State's total hedge fund investments to between $12 million and $14 million, Ms. Nopper said. The endowment's target asset allocation is 50% equities, 25% fixed income and 25% alternatives. Funding for both came from reducing small-cap equity and cash.
Seattle City Employees also added to existing hedge fund investments, said Norman Ruggles, executive director. The fund had $60 million in fund-of-funds investments with Seattle-based Quellos Capital Management LP. Then in February, the plan hired Advent Capital Management LLC, New York, to manage $10 million in a convertible arbitrage hedge fund.
Mr. Ruggles said the fund plans to conduct an asset-allocation study later this year, which could lead to increased investments in alternatives, including hedge funds.
The Virginia Retirement System made one of the largest and most talked-about allocations to hedge funds this year, placing $300 million in a fund of funds run by Ivy Asset Management Corp., Garden City, N.Y. What made the hiring interesting was that VRS picked the 15 managers in the fund with help from Ivy, said Nancy C. Everett, chief investment officer. She said the system's investment board approved the hedge fund investment only in certain strategies, specifically distressed, long-short equity and market neutral. So VRS designed a fund with managers who follow only those strategies. Ms. Everett said the goal was diversification.
Staff members at the $146.9 billion California Public Employees' Retirement System, Sacramento, in June recommended boosting that plan's hedge fund investments to between 2% and 4% of its global equities allocation, or between $2.75 billion and $5.5 billion, based on CalPERS' assets as of April 30. CalPERS already had committed to investing 1% of global equities in hedge fund investments.
At a conference last spring, CalPERS' Chief Investment Officer Mark Anson said he expects future allocations to include managed futures. Mr. Anson also has said publicly he wants to get more alpha - or return based on manager skill - from CalPERS' investment portfolio.
Timothy Cahill, MassPRIM board chairman and Massachusetts state treasurer, said in early June that PRIM would allocate 5% of its assets for hedge fund strategies. The fund has put out a request for proposals for an absolute return consultant, but no due date was set. Mr. Cahill said MassPRIM wanted to use hedge funds as a way to diversify and reduce risk.
Another Massachusetts fund, the $500 million Middlesex County Retirement System, East Cambridge, hired Consulting Services Group LLC, Memphis, Tenn., to manage $25 million in funds of hedge funds.
That hiring is pending approval from a state commission that monitors and oversees public pension funds.
Other funds are still looking closely at hedge funds and may make investments next year. Kern County Employees' Retirement Association, Bakersfield, Calif., plans to invest $50 million in hedge funds, said David J. Deutsch, executive director of the $1.7 billion system. Kern County is in what Mr. Deutsch called "education mode," as he occasionally brings in hedge fund managers to speak to the association board.
"I made it clear to the board that we wouldn't do anything quickly," Mr. Deutsch said. "We agreed there's a lot of hoopla surrounding hedge funds now and we wanted to know how that may affect investments, so we decided to stand clear."